Sembcorp Marine - DBS Research 2018-03-27: Best Proxy To Ride On O&M Recovery

Sembcorp Marine - DBS Vickers 2018-03-27: Best Proxy To Ride On O&M Recovery SEMBCORP MARINE LTD S51.SI

Sembcorp Marine - Best Proxy To Ride On O&M Recovery

  • We remain positive on future order flows, post NDR.
  • Expecting the first Gravifloat contract this year.
  • Optimisation and margin recovery to drive re-rating.
  • Reiterate BUY and Target Price of S$2.90.

Maintain BUY and Target Price of S$2.90, based on 2.4x FY18 P/BV (0.5SD below mean). 

  • Sembcorp Marine (SMM)'s share price pullback from the recent high of S$2.80, has removed the M&A premium ascribed, thus providing a better entry point to position for a sector recovery.
  • We favour Sembcorp Marine as a key proxy to the recovery in the O&G and O&M sectors, with strong order wins as key re-rating catalyst.
  • Management shared its optimism on the order outlook and earnings recovery in its recent NDR to Hong Kong and Tokyo.

Where We Differ: More bullish on Sembcorp Marine (SMM)’s contract wins. 

  • Order wins, a critical leading indicator for earnings recovery, is set to rise in the next 12 months. We believe SMM’s strong order pipeline would translate into S$3bn or more in new orders, in 2018, which could potentially include
    1. a semi-submersible production unit for Shell’s Vito at S$400-800m;
    2. Newbuild FPSO for Energean’s Karish-Tanin project at S$400m;
    3. two large Compressed Gas Liquid carriers for SeaOne Caribbean valued at S$800m in total; and
    4. a Gravifloat (SMM’s proprietary technology) modularised LNG exporting terminal for Poly-GCL at c.S$1bn.

Reactivation of Sete Brasil rig orders. 

  • The landmark deal to sell nine jackup rigs to Borr Drilling and the disposal of harsh environment semisubmersible rig West Rigel have eliminated the key overhanging concerns on SMM. The restructuring of customer Sete Brasil is also seemingly closer to a resolution, as Petrobras and Sete are reported to have struck a rig deal.
  • Singapore rigbuilders are well-positioned to deliver 2 rigs each (which are in the advanced stages of construction) out of Sete Brasil’s existing 13 orders (c.S$1bn each).


  • Our target price of S$2.90 is based on 2.4x FY18 P/BV, pegged to 0.5SD below its mean valuation since 2004. SMM’s book value has already been written down after the massive S$609m provisions taken in FY15.

Key Risks to Our View

  • Key downside risks are sustained low oil prices which would affect rig count and newbuilding activities, execution risks in new product types, and corruption allegations in Brazil that, if found guilty, could lead to financial and reputational loss.
  • Upside risk could come from privatisation or M&A activities, as well as the write-back of provisions from successful deliveries or vessel sales.

KEY TAKEAWAYS FROM NDR: Critical to share price; order wins and margins/ scenario analysis 

Order win and margins are two critical factors for SMM.

  • During the NDR to Hong Kong and Tokyo, order win and margin expectations are the two key issues raised by investors. In an attempt to address these, we take the cue from the empirical numbers in 2005-2010 cycle and extrapolate them for this 2017-2022 cycle. We believe SMM is at the tipping point for order wins and earnings recovery. 
  • In this cycle, the operating environment is more competitive and the recovery will be more gradual. We expect larger-scale projects and thus lower margins, ROE and PB. Assuming order win could grow to S$5bn in 2019 and strong margin recovery follows through, SMM might re-rate to mean valuation of 3x PB or S$3.90.

Q1. What are SMM’s competitive advantages against global peers? 

  • SMM: The state-of-the-art new facility – Tuas Boulevard Yard (TBY), which is designed to maximise operational synergy, production efficiency and critical mass with optimised docking and berthing facilities as well as equipped with highly automated steel fabrication facilities, enhances SMM’s competitive edge and capability to take on large-scale newbuild projects such as newbuild FPSO and FPU that were previously clinched by its global peers.
    SMM has demonstrated its strong ability to climb the learning curve since mid-2000 – building first newbuild semisubmersible rig, drillship and most recently newbuild FPSO.
  • DBS view: Singapore yards offer flexibility, as well as strong innovation and R&D capability to accommodate client requests on rig customisation as opposed to Korean yards’ standardisation strategy with minimal headroom for modification and customisation. This is a distinctive advantage in the current moderate oil price environment, as oil majors are more inclined towards customised and cost-efficient solutions. SMM’s labour cost is also more competitive by leveraging on lower-cost skilled foreign labour.
    The first drillship orders from Transocean was a testament to SMM’s TBY facilities and capability as these are compact designs relative to Korean-built ones.

Q2. What are your order win expectations? 

  • SMM: Management is hopeful that the strong level of enquiries, mainly for production related solutions, as well as Gravifloat projects, could lead to a recovery in order wins.
  • DBS view: We have assumed S$3bn order wins in our model, which we believe is poised for upward revisions. Of which half is expected to come from Gravifloat solutions while the other half largely from production-related facilities.

Q3. When do you expect to ink your first Gravifloat contract? 

  • SMM: SMM is in various stages of discussions with several potential customers, some of which could materialise in 2018. SMM’s Gravifloat LNG terminal provides a unique cost efficient modular option to customers, and could emerge as the next mainstream product of SMM. The value of these units can range from US$200-$300m for importing LNG terminals, and up to c.US$1bn for exporting LNG terminals.
    Besides, Gravifloat technology could also be deployed to other applications such as
    1. Integrated LNG to Power – an integrated 3-in-1 solution for near-shore LNG receiving; LNG storage and regasification; and power generation for capacities from 30-400MW of power; and
    2. LNG bunkering modules that can be installed in the open sea with multiple quay sides, away from busy port traffic. SMM could work with its parent, Sembcorp industries on these solutions for gas-fuelled power facilities.
  • DBS view : According to Upstream, SMM is in the advanced stage of negotiations with a potential customer, China's POLY-GCL Petroleum Group Holdings Ltd (“Poly-GCL”) – a JV between state-owned China POLY Group Corporation and privately owned Hong Kong-based Golden Concord Group, for modularised LNG exporting terminal worth > S$1bn. In Nov 2017, Poly-GCL has signed a memorandum of understanding (MoU) to invest US$4bn in a natural gas project that includes a natural gas pipeline (to transport gas from Ethiopia to Djibouti), a liquefaction plant and an export terminal.
    The signing of the Poly-GCL MoU sends a positive signal on the progress of the project, despite delays of nearly a year due to various reasons, including complex negotiations with the Djiboutian government on gas pipeline construction to the port of Djibouti. The crystallisation of this long-awaited project serves as a confidence booster for SMM’s new Gravifloat technology.

Q4. What sort of normalised margins or ROE could we expect? 

  • SMM: SMM has right-sized its workforce and accelerated the shipyards integration at TBY. Current low margin is partly due to the legacy of industry-wide low order wins in the past two years but shipyards could see a recovery with stronger new order flows moving ahead. The optimisation might take 2-3 years as margins are a function of productivity and learning curve improvement.
  • DBS view: To be prudent, the initial margin recognition, especially for new products, will be low. Hopefully, we could see a margin recovery to the 6-8% target soon with the potential writeback of variation orders and resumption of Sete projects. We believe Gravifloat solutions could potentially generate similar margins like those for rigs in the past, at a steady stake when economies of scale are achieved.
    In an attempt to address these, we take the cue from the empirical numbers in 2005-2010 cycle and extrapolate them for this 2017-2022 cycle. We believe SMM is at the tipping point for order wins and earnings recovery. In this cycle, the operating environment is more competitive and the recovery will be more gradual. We expect larger-scale projects and thus lower margins, ROE and PB. Assuming order win could grow to S$5bn in 2019 and strong margin recovery follows through, SMM might re-rate to a mean valuation of 3x PB or S$3.90.

Q5. Update on Sete Brazil’s projects 

  • SMM: SMM has initiated an internal investigation into the bribery allegations in Brazil in 2015. The investigation is still ongoing, and it is not aware of any irregularities thus far.
    Meanwhile SMM’s Brazilian agent – Mr Guilherme Esteves de Jesus is defending the charges against him on paying bribes to secure the Drillship contracts. Court hearing of the charges is not yet known.
  • SMM: It has been reported that Petrobras and Sete Brasil (Sete) have reached an agreement on the construction and delivery of four drilling rigs while terminating contracts for another 24 rigs. While the units to be delivered were not disclosed, they are believed to be the ones near completion.
  • DBS: Will there be write-back of the provisions? The four deliveries are likely to be the first two rigs each from Keppel and SMM. SMM has collected substantial payments of c.S$2.7bn and made provisions of c.S$329m to account for the shortfall, i.e. receivables owed to the yard. We believe some compensation should be made to shipyards as an incentive to deliver the units. In addition, additional investments of ~S$100-200m will be required to complete the units.
    Actual financial impact is dependent on
    1. rig price and payment agreed to complete those units;
    2. any compensation on the receivables payable to shipyards; and
    3. plans on the other four half-built units. 

    We do not rule out possibility of Sete selling the other half-built rigs to other players in Brazil.

Q6. Capex guidance and ideal gearing level? 

  • SMM: Management has guided for a capex range of S$200- 500m in 2018, dependent on the development of TBY Phase III, on a need basis. Management aims to keep net gearing below 1x.
  • DBS: In fact, assuming full payment from Borr Drilling, which will take 3-5 years, net gearing would be lowered to 0.7-0.8x.

Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2018-03-27
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